There is a huge amount of research showing that money, when earned, has a generally positive association with happiness. The problem is when it is unearned. Happiness comes not from money per se, but from the value creation it is rewarding.

What can the state lottery teach us about how to deal with the fiscal cliff? Quite a bit, actually.

Last month, two families in Missouri and Arizona had their dreams come true when they shared the largest Powerball lottery jackpot in history: $587 million. "We are truly blessed," one of the winners told the press.

Perhaps. People always imagine all the nice things that would happen to them if they won the lottery: They would travel more, buy a beautiful home, start a foundation or quit a tiresome job. Rarely do people say, "If I won the lottery, I'd marry somebody who doesn't love me, buy a bunch of things I don't really want, and then start an ugly alcoholic spiral."

But hitting the jackpot generally leads to unhappiness. A famous 1978 study of major lottery winners in the Journal of Personality and Social Psychology showed that while the winners experienced an immediate happiness boost right after winning, it didn't last. Within a few months, their happiness levels receded to where they had been before winning. As time passed, they found they were actually less happy than they had been before winning.

Does this suggest that money makes us unhappy? Not at all. There is a huge amount of research showing that money, when earned, has a generally positive association with happiness. The problem is when it is unearned, when raw purchasing power is untethered from hard work and merit. Above basic subsistence, happiness comes not from money per se, but from the value creation it is rewarding.

The University of Chicago's General Social Survey reveals that people are twice as likely to feel "very happy" about their lives if they feel "very successful" or "completely successful" at work, rather than "somewhat successful." The differences persist whether they earn more or less income.

Entrepreneurs of all types rate their well-being higher than do members of all other professional groups in America, according to years of polling by the Gallup organization. And it's not because of the money. The employment website CareerBuilder.com reported in 2011 that small business owners made 19% less per year than government managers.

While earned success facilitates the pursuit of happiness, unearned transfers generally impede it. According to the Panel Study of Income Dynamics, going on the welfare rolls increases by 16% the likelihood of a person saying he or she has felt inconsolably sad over the past month (even after controlling for poverty and unemployment). A study by economist John Ifcher at Santa Clara University shows that single mothers who were required by the 1990s welfare reform to work for their benefits—and therefore lost leisure time, had to find child care and the like—were still significantly happier about their lives after the reforms than before.

All this data relates to our policy debates because every year, fewer and fewer people earn their way in America without a government subsidy. As my colleague Nicholas Eberstadt has written, entitlements have doubled as a percentage of the ballooning federal budget since 1960. Today, more than half of American households receive government transfer benefits.

And this isn't just a case of senior citizens taking the Social Security they have paid for. Unearned transfers are exploding. Consider that the number of Americans receiving disability benefits has increased almost 20-fold since 1960, to 8.6 million today from 455,000. The Tax Foundation notes that nearly 70% of Americans now take more out of the tax system than they pay into it.

It is a simple fact that the United States is becoming an entitlement state. The problem with this is not just that it is bankrupting the country. It is that the entitlement state is impoverishing the lives of the growing millions dependent on unearned resources. The good news is that we have a golden opportunity to rein in entitlements, for the first time in many years.

But there is bad news, too. President Obama argues that the real problem is undertaxing the public, not overspending on entitlements. He is currently asking Congress for $1.3 trillion in tax increases over a decade but less than $1 trillion in spending cuts—largely deferred, meaning much of that may not even take place. A study by Ernst & Young shows that Mr. Obama's proposed tax hikes would force small businesses to eliminate about 710,000 jobs.

Mr. Obama's proposal suggests he is entirely comfortable with an entitlement state. His telling entrepreneurs that they weren't responsible for their success on the specious grounds that government was responsible for the country's infrastructure—"You didn't build that"—wasn't just an inartful turn of phrase. It implied he is blind to the moral difference between what is earned and what is unearned.

Before us today is a chance to improve the true welfare of our nation while changing our overspending ways. By reforming entitlements and the tax system instead of extracting more money with higher tax rates, the economy could be reoriented away from unearned transfers to earned wages. This would make the economy fairer and sounder. And in the process it could build a happier country for ourselves and our children.